Court Opinion

ID: 9447609
Source: CourtListenerOpinion
Date Created: 2023-08-03 22:38:41.717415+00
Date Added: 2024-06-11T17:31:06.507851
License: Public Domain

KALODNER, Circuit Judge
(dissenting).
I would reverse the Order of the District Court.
I would do so for these reasons:
First, the deposit “set-off doctrine” is not applicable to bank accounts of receivers in bankruptcy since they are in custodia legis.
Second, assuming arguendo, that the doctrine is applicable to bankruptcy receivers’ accounts, there was error in its application in the instant case for these reasons:
(a) The designation “Special Machinery Account” was sufficient to put the bank on inquiry that the funds in it were at the minimum the subject of a claim of ownership by someone other than the bankruptcy receiver since at the time the account was opened there were already in existence a Receivers “General Account” and a Receivers “Tax Account” ;
(b) Assuming further, that the designation “Special Machinery Account” was not of such a nature as to put the bank on inquiry, under the general “equitable rule” prevailing in deposit set-off situations, even though a bank is without knowledge, or notice of facts putting it on inquiry, that another than the depositor has an interest in the funds deposited in his name, where such an interest exists the bank cannot appropriate them.
Third, the record establishes as “clearly erroneous” the Referee’s fact-findings, affirmed by the District Court, that the bank “had no knowledge that the Receivers could not use the account designated ‘Special Machinery Account’ for general purposes”, and that “Girard had no knowledge that any person other than the Receivers had an interest in or lien against said account”.
As to the first point:
From the time of the filing of the bankruptcy petition, the assets of the bankruptcy estate are in custodia legis and the bankruptcy court has exclusive jurisdiction and it alone has the sole right to determine the validity of any and all claims against the bankruptcy estate. In re Ripp, 7 Cir., 1957, 242 F.2d 849.
Money of a bankrupt estate collected or received by the receiver is in custodia legis. Section 61 of the Bankruptcy Act (11 U.S.C.A. § 101) expressly provides in part:
“The judges of the several courts of bankruptcy shall designate, by order, banking institutions as depositories for the money of estates under this Act * *
Section 47 of the Act (11 U.S.C.A. § 75) provides in part:
“Trustees shall * * * (2) deposit all money received by them in designated depositories; * * *
(4) disburse money only by check or draft on such depositories * * 1
General Order No. 29 (11 U.S.C.A. following section 53), prescribed by the Supreme Court pursuant to the provisions of the Bankruptcy Act, provides in part as follows:
“No moneys deposited as required by the Act shall be drawn from the depository unless by check or draft, signed by the clerk of the court or by a receiver or trustee, and countersigned by the judge, or by a referee, or by the clerk or his assistant under an order made by the judge, stating the date, the sum, and the account for which it is drawn.”
As was stated in American Surety Co. of New York v. First Nat. Bank in West Union, W. Va., 4 Cir., 1944, 141 F.2d 411, 413, certiorari denied 322 U.S. 754:
*456“It is perfectly clear that the purpose of these provisions was to protect the funds of bankrupt estates, not merely to designate banks in which trustees might deposit funds without incurring personal liability * * * »
It is settled that the right of set-off in bankruptcy is governed by the provisions of Section 68 of the Bankruptcy Act. McCollum v. Hamilton Nat. Bank, 1938, 303 U.S. 245, 248, 58 S.Ct. 568, 82 L.Ed. 819.
Section 68 provides as follows:
“a. In all cases of mutual debts or mutual credits between the es- ■ tate of a bankrupt and a creditor the account shall be stated and one debt shall be set off against the other, and the balance only shall be allowed or paid.
“b. A set-off or counterclaim shall not be allowed in favor of any debtor of the bankrupt which (1) is not provable against the estate and allowable under subdivision g of section 57 of this Act; or (2) was purchased by or transferred to him after the filing of the petition or within four months before such filing, with a view to such use and with knowledge or notice that such bankrupt was insolvent or had committed an act of bankruptcy.” 52 Stat. 878.
The provisions stated make it clear that the right of set-off which they permit relate only to “mutual debts or credits” existing prior to the filing of the bankruptcy petition and not those arising thereafter. Inherent in the majority’s disposition is the assumption that a right of set-off may arise after bankruptcy has occurred. I can see no basis for such an assumption. It was held in Desser, Rau & Hoffman v. Goggin, 9 Cir., 1957, 240 F.2d 84, 86, certiorari denied 355 U.S. 813, 78 S.Ct. 12, 2 L.Ed.2d 30, that “ * * * where no right of setoff or any other right against the fund existed before bankruptcy that one cannot now establish the setoff.” Again, in Avant v. United States, D.C. E.D.Va.1958, 165 F.Supp. 802, at page 805, it was said:
“The principles governing the applicability of setoff in bankruptcy proceedings is stated ■ in McDaniel Nat. Bank v. Bridwell, 8 Cir., 74 F. 2d 331. It was there held that mutuality of debts and credits between the bankrupt and the party claiming the right of setoff must exist when the petition in bankruptcy was filed; the latter date being the time when the right of setoff is measured * * (Emphasis supplied.)
As succinctly stated in 4 Collier on Bankruptcy, para. 68.10, page 743 (14th ed. 1942):
“Generally speaking, the rights of parties under § 68 are adjusted as of the date of bankruptcy * *
Counsel for the bank has cited two cases2 in support of its contention that the “right of a bank to make a set off against an overdrawn bank account has been upheld in bankruptcy proceedings.” The cases cited are completely inapposite to the instant situation; in both, the banks involved had prior to bankruptcy applied the bankrupt’s deposit in set-off of a then existing indebtedness of the bankrupt. Here the bank set-off against overdrafts by the Receivers in their “General Account” funds in the Receiver’s “Special Machinery Account.”
In summary on this phase of the case, I am of the opinion that (1) the “set-off doctrine” is inapplicable to bank accounts of receivers or trustees in bankruptcy since such accounts, as property of the bankrupt estate, are in custodia legis; (2) the statutory scheme of the Bankruptcy Act does not sanction a set-off with respect to a debt arising to bankruptcy, and (3) the Act does not permit a set-off claim arising out of a bank’s *457dealings with a bankruptcy trustee or receiver.3
Coming now to the point presented by the majority’s determination that the designation “Special Machinery Account” was not of such character as to put the bank on notice of its restricted nature so as to make its balance unavailable for set-off against the overdrafts in the Receivers’ “General Account”.
I agree, of course, with the majority that the issue is one to be governed by federal law. “The bankruptcy act prescribes its own criteria for distribution to creditors. In the interpretation and application of federal statutes, federal not local law applies.” Prudence Realization Corporation v. Geist, 1942, 316 U.S. 89, 95, 62 S.Ct. 978, 982, 86 L.Ed. 1293.
The majority has cited three federal cases as authority for the proposition that “where a bank has neither actual notice nor notice of facts sufficient to put it on inquiry regarding the true character of the deposit it may apply the deposit to the overdrafts in the depositor’s general account.” These cases are not apposite nor analogous in any respect to the instant case. None of them involved bankruptcy receivers’ accounts. Taking them in the order cited by the majority: in In re Greater Pythian Temple Ass’n of New York, D.C.N.Y.1937, 19 F.Supp. 762, 764 the asserted “special account” was opened by the debtor in reorganization prior to the filing of the reorganization petition; in Commercial National Bank of Independence, Kan. v. Stockyards Loan Co., 8 Cir., 1926, 16 F.2d 911, 916, certiorari denied 275 U.S. 547, 48 S. Ct. 84, 72 L.Ed. 418, there was no bankruptcy at all, and in In re Goll, D.C.N.Y. 1925, 8 F.2d 101, the asserted “special account” of the bankrupt depositor was invaded by the bank prior to bankruptcy.
“With an interested eye towards the Pennsylvania decisions,” the majority has cited two cases in support of its holding that the designation “Special Machinery Account” did not put the bank in the instant case on notice of its restricted nature.
It must be submitted that the cases cited, on analysis, afford little sustenance to the majority’s view.
*458In the first of these cases, Franklin Savings & Trust Co. of Pittsburgh v. Clark, 1925, 283 Pa. 212, 129 A. 56, it was ruled that funds in an account designated “John W. Garland, Special” were subject to set-off by the bank against Garland’s matured note, the Court holding (283 Pa. at page 219, 129 A. at page 58) that the designation “Special” was “insufficient [of itself] to put the bank on inquiry”, since “the word ‘special’ has no particular significance, as trustee, administrator and the like.” (Emphasis supplied.)
The second of the Pennsylvania cases cited by the majority, Sherts v. Fulton National Bank of Lancaster, 1941, 342 Pa. 337, 21 A.2d 18, 19, held that the bank could not resort to an account “H. Edgar Sherts, Attorney” because the term “Attorney” was sufficient to put the bank on notice as to its restricted nature, but that the designation of a second account, “H. Edgar Sherts, Farm Account”, was not of a character sufficient to afford “notice” to the bank that the funds deposited in it “belonged to someone other than the depositor”.
Anent its holding that the term “Attorney” was sufficient to put the bank on notice the Court said (342 Pa. at page 339, 21 A. at page 19):
“All the authorities agree that if a bank has knowledge, or notice of facts enough to put it upon inquiry, that the funds in a depositor’s account actually belong to a third person, it may not apply such funds to a debt owed to it by the depositor individually- * * *. The word ‘attorney’ * * * clearly raises a presumption, when used in connection with a bank account, that the funds therein belong to some undisclosed principal, clients, or beneficiaries.”
And at page 340 of 342 Pa., at page 20 of 21 A.:
“ * * * It is sufficient-that the bank have knowledge that a fiduciary relation exists; it is not necessary that it know the identity of the beneficiaries.”
I do not agree with the majority’s view that the designation “Farm Account” bears “a close similarity to the marking of the account before us” [Special Machinery Account] having in mind that preceding the latter description was the phrasing “Morton Q. Klein and William East, Receivers”.
It may be noted parenthetically, that the bank in this case was denied recourse to the “Farm Account” on the finding below that the funds in it belonged to Sherts’ clients.
In an earlier Pennsylvania case, Franklin Trust Co. of Philadelphia, 1935, 319 Pa. 367,179 A. 592, the Pennsylvania Supreme Court held to be inviolate accounts captioned “Insurance Account” and “Agency Account”. In Trestrail v. Johnson, 1929, 298 Pa. 388, 396, 148 A. 493, not cited by the majority, it was held that accounts designated “Thomas W. Allison, Sheriff” could not be invaded. These two cases were decided after Franklin Savings & Trust Co. v. Clark, supra, cited by the majority.
In Ryan Brothers, Inc. v. Curwensville State Bank, 1955, 382 Pa. 248, 114 A.2d 178, the Sherts and Franklin Trust Co. cases were cited with approval, and their doctrines reaffirmed.
With respect to them, the Court said (382 Pa. at page 254, 114 A.2d at page 181):
“In * * * Franklin Trust Co. of Philadelphia * * * it was held that a bank may not set off against a debt due it by a depositor, individually, deposits in accounts in the name of the depositor with special designations added where the funds represented by such deposits are in fact the property of third persons, It was there directly held that this is so even though the bank has no knowledge, beyond the special designations of the accounts, of any facts indicating the nature of the depositor’s business or the nature of the funds contained in the accounts. In the Sherts case, supra, it was specifically remarked that in the Franklin *459Trust Co. case we had ranged ourselves definitely with those jurisdictions which have adopted the so-called ‘equitable rule’ there followed. See, also, Witherow v. Weaver, 337 Pa. 488, 491, 12 A.2d 92.”
The foregoing makes it clear that the majority’s reliance, and that of the Referee and the District Court, on Franklin Savings & Trust Co. v. Clark, and Sherts v. Fulton National Bank of Lancaster, supra, was not justified.
It supports the view expressed at the outset of this dissent that even though the designation “Special Machinery Account” was not sufficient to put the bank on inquiry, and even though it was without knowledge that someone other than the Receivers had an interest in the account, that such other interest, if it existed, precluded the bank from appropriating the funds in the “Special Machinery Account.”
In the instant case the account in question consisted of funds realized from the sale by the Receivers of machinery and equipment which had been distrained by the bankrupt’s landlord and the account was to be kept intact until the bankruptcy court determined the validity of the landlord’s lien. Under the general “equitable rule” if the landlord were entitled to the funds in the account in question the bank could not resort to it. Here the bank was permitted, in disregard of the “equitable rule” to resort to the account before judicial determination of the issue of its ownership by the landlord.
The “equitable rule” which prevails in Pennsylvania has been subscribed to by federal courts time and again. Prudence Realization Corporation v. Geist, supra; Pepper v. Litton, 1939, 308 U.S. 295, 60 S.Ct. 238, 84 L.Ed. 281; Cumberland Glass Mfg. Co. v. DeWitt, 1915, 237 U.S. 447, 455, 456, 35 S.Ct. 636, 59 L.Ed. 1042; In re Potts, 6 Cir., 1944, 142 F.2d 883, 887, certiorari denied 324 U.S. 868, 65 S.Ct. 910, 89 L.Ed. 1423; Inter-State National Bank of Kansas City v. Luther, 10 Cir., 1955, 221 F.2d 382, 389, certio-rari granted 350 U.S. 810, 76 S.Ct. 77, 100 L.Ed. 726, certiorari dismissed by stipulation, 350 U.S. 944, 76 S.Ct. 297, 100 L.Ed. 823; First National Bank of Portland v. Dudley, 9 Cir., 1956, 231 F.2d 396, 401, 402.
There is still another aspect to this-situation which deserves noting in applying equitable principles.
In the instant case, where the bank resorted to the balance in the “Special Machinery Account”, even the most cursory scrutiny discloses this situation:
The bank knew it was dealing with Receivers in bankruptcy with respect to their General Account which was designated “Receivers Account”. It must be held to have knowledge that Receivers under the Bankruptcy Act may not borrow money without prior authorization by the bankruptcy court. Here the bank, by knowingly permitting repeated and increasing overdrafts by the Receivers, was in substance lending the Receivers money without prior authorization by the bankruptcy court. With respect to these overdrafts the record establishes that the Receivers’ General Account which was opened March 28, 1957 had an overdraft of $1,795.09 on May 29, 1957; overdrafts in June, 1957 ranging from $1,960.27 on June 11 to $11,862.72 on June 28; and the culminating overdraft of $17,281.38 on July 8, 1957 which was “satsified” by the appropriation by the bank on that date of $17,281.38 of the funds in the “Special Machinery Account”.
That the bank was at all times aware of the overdrafts is evident from this testimony by Smedley (assistant treasurer) :
“I had been watching the overdrafts in the general account.”
The sum total of the foregoing is that the bank knowingly made loans, via the overdrafts, to the Receivers in the absence of authorization for such loans by the bankruptcy court, and in the application of the “equitable rule” prevailing in deposit set-off situations, should not be permitted to resort to the “Special Machinery Account”, which, irrespective of *460the issue of notice by reason of its designation, or lack of specific notice to the bank of the nature of that Account, was created pursuant to Court order relegating “to the fund realized from the sale” the machinery liens asserted by the bankrupt’s landlord.
Finally, as to the point that the record establishes as “clearly erroneous” the Referee’s fact-findings, (affirmed by the District Court) that the bank “had no knowledge that the Receivers could not use the account designated ‘Special Machinery Account’ for general purposes”, and that “Girard [bank] had no knowledge that any person other than the Receivers had an interest in or lien against said account”:
At the hearing before the Referee, Morton Q. Klein, one of the Receivers of the bankrupt estate, testified that at the time of the opening of the “Special Machinery Account” he advised William J. Smedley, assistant treasurer of the Gir-ard Trust Com Exchange Bank, in charge of “customer relations”, of the restricted nature of the account under the bankruptcy court’s restrictive order.
Klein’s testimony was explicit on that score as appears from the following excerpt from the Notes of Testimony taken during the hearing before the Referee on April 30, 1958: 4
“ * * * I opened all my accounts with Mr. Smedley. I told him it was a special machinery account; it will be an inactive account; it will not be used for the simple reason that the Court will not permit us to use that money on account of the distraint for rent at the Adams and Leiper property * *
In response to this question: “Did Mr. Smedley make any comment at the time that the account was being opened?” Klein testified:
“I mentioned the fact that it was opened as a Special Machinery Account because I am not permitted to use the money. * * *
“I think he [Smedley] said, ‘Why can’t you use it?’ or something like that. I said, ‘Because we have a Court order. We can’t use the money. It is a Special Machinery Account, untouchable.’ ”
Smedley, on direct examination, testified that he had known Klein for “probably twenty years” as a customer of the bank and that he had opened accounts for him during that period. He also testified that he handled the opening of the bankruptcy estate’s general account on March 28, 1957 and the “Special Machinery Account” on May 13, 1957, and that he was “fully familiar with the operation of those two accounts.”
On the score of Klein’s testimony that he had advised him of the restricted nature of the “Special Machinery Account” at the time of its opening, Smedley did not deny or challenge it but merely said that he didn’t “remember” or “recall” notice of the restriction.
On direct examination by the bank’s counsel, Smedley was asked this question:
“Now at the time this account was opened, Mr. Smedley, did Mr. Klein refer to any decree that had been entered by the Court in which the Court restricted the use of these funds so that they could not be used until further order of the Court?”
Smedley’s reply to this question was:
“I don’t remember.”
Again, when asked by the bank’s counsel:
“Do you recall whether you were ever notified by Mr. Klein or by anybody else that this account could not be used to take care of overdrafts from the general account?”
Smedley’s answer was:
“I don’t recall.”
It is apparent from the foregoing that Smedley’s testimony was non-negating as far as Klein’s testimony was concerned and afforded no basis whatsoever for the Referee’s curious conclusion that *461it raised “a basic factual dispute” on the issue as to whether Klein had advised Smedley of the restricted nature of the “Special Machinery Account”. The Referee resolved the asserted “basic factual dispute” by making the fact-finding “that the restriction on this Special Machinery Account was not brought to the Bank’s attention”, and “that the Bank was without knowledge of the fact that third persons had an interest in the fund of the depositor.”
Throwing light on the “reasons” which motivated his rejection of Klein’s testimony is this illuminating statement in the Referee’s “Opinion and Order Sur Petition.”
Said the Referee:
“ * * * The question could rightly be asked — is Mr. Klein trying to protect himself, would he be responsible to the Bank in the question of a surcharge upon his bond, is he attempting to protect his own position from a review of the entire evidence in this case?”
With respect to the question posed by the Referee it can only be said that if Klein sought to protect himself from responsibility to the bank for his overdrafts on his General Account it would have been to his advantage not to have testified that he had advised Smedley of the restricted nature of the “Special Machinery Account” because there would not then have been raised any question as to the bank’s right to invade it, and the bank having recouped the overdraft in the General Account would have had no claim to assert against Klein, assuming arguendo that the overdraft would in any event have given rise to a claim against Klein. The Referee’s inference in his posed question that the bank could have sought a surcharge against Klein “upon his bond” for the overdrafts is to say the least, baffling, since his bond did not run to the bank but to the benefit of the bankruptcy estate.
What has been said makes it clear that the Referee’s stated fact-findings were “clearly erroneous” and their adoption by the District Court is in the same category. That being so, this Court should reverse the District Court’s “Order”.
There remains this to be said.
The District Court by permitting the bank to set-off the $17,281.38 overdraft in the Receivers’ General Account against the “Special Machinery Account” deposit was according to the bank a lien status which it would not have had under the Bankruptcy Act had it in fact been duly authorized by the Bankruptcy Court to make a $17,281.38 loan to the Receivers. Under Section 64, sub. a(l) of the Bankruptcy Act court-authorized loans made to receivers to finance their operations are in the category of “the actual and necessary costs and expenses of preserving the estate” and are accorded first priority as an “expense of adminis,tration”.5 Here the bank, despite the fact that its overdrafts — over an extended period and in large amounts — were not authorized by the Bankruptcy Court, emerges, by reason of the District Court’s action, in the status of a lien holder rather than a first priority claimant. This despite the fact that borrowings by a receiver or trustee not authorized by the Bankruptcy Court are not a charge upon the bankruptcy estate. Amick v. Hotz, 8 Cir., 1939, 101 F.2d 311, certiorari denied 307 U.S. 637, 59 S.Ct. 1033, 83 L.Ed. 1518; Standard Capital Corporation v. Saper, 2 Cir., 1940, 115 F.2d 383.
For the reasons stated I would reverse the Order of the District Court.

. The provisions cited are applicable to Receivers. 3 Collier on Bankruptcy, para. 61.02, p. 1349 (14th ed. 1950).

. American Bank of Alaska v. Johnson, 9 Cir., 1917, 245 F. 312 and Tomlinson v. Bank of Lexington, 4 Cir., 1906, 145 F. 824.

. It may be noted that in 3 Remington on Bankruptcy, (1957 ed.) Section 1477, page 483, it is said:
“ * * * it seems, moreover, that not even indebtedness of such an officer [bankruptcy trustee or receiver] to tbe bank in bis official capacity can be used as a setoff, since tbe funds are in custody of tbe court.”
As tbe majority bas pointed out (footnote 3) Remington bas added tbe further statement that “An exception may exist, however, where tbe trustee * * * bas been authorized to continue tbe bankrupt’s business and tbe bank has made advances to enable him to do so.” and in a footnote cites Johns v. United Bank & Trust Co., 9 Cir., 1926, 15 F.2d 300, certiorari denied 273 U.S. 753, 47 S.Ct. 457, 71 L.Ed. 874. A reading of that case discloses that it did not involve advances by a bank to a bankruptcy trustee to enable him to continue operation of the bankrupt’s business. Tbe bank loans were made in tbe Johns case to trustees operating under an assignment for tbe benefit of creditors and not to a bankruptcy trustee, and tbe right to set-off was asserted by the lending banks against tbe bank accounts of tbe assignment trustees and not against tbe bank account of the bankruptcy trustee.
The majority bas also cited (footnote 8) Lebanon Iron Co. v. Donnelly & Co., D.C.E.D.Pa.1928, 29 F.2d 411, where a bank was permitted to set-off bankruptcy receivers’ deposits against loans made on authorized receivers’ certificates. With respect to that case it must be pointed out that tbe District Court’s opinion does not disclose that consideration was given to the set-off provision of Section 68 of tbe Bankruptcy Act.
Tbe majority’s citation of Durkee v. National Bank, 5 Cir., 1900, 102 F. 845, as being to the same effect as the Lebanon Iron Co. case is inapposite. Tbe Durkee case did not involve the application of tbe Bankruptcy Act. Tbe receivership there was in equity and not in bankruptcy.
It may be stated parenthetically that in the Lebanon Iron Works case tbe District Court relied on Durkee v. National Bank, supra and Johns v. United Bank & Trust Co., supra, despite tbe fact that these two cases were inapposite to the issue there presented.

. Notes of Testimony, pages 8 and 9.

. In re Delaware Hosiery Mills, 3 Cir., 1953, 202 F.2d 951, 952, 953; In re Columbia Ribbon Co., 3 Cir., 1941, 117 F. 2d 999, 1002.